TREASURY INSPECTOR GENERAL FOR TAX
ADMINISTRATION

Low Participation and Tax Return Volumes Continue to Hinder
the Transition of Individual Income Tax Returns to the Modernized e-File System

September 29, 2011

Reference Number:†
2011-40-131

This report has cleared the Treasury Inspector
General for Tax Administration disclosure review process and information
determined to be restricted from public release has been redacted from this
document.

LOW PARTICIPATION AND TAX RETURN
VOLUMES CONTINUE TO HINDER THE TRANSITION OF INDIVIDUAL INCOME TAX RETURNS TO
THE MODERNIZED E‑FILE SYSTEM

Highlights

Final
Report issued on September 29, 2011 †

Highlights of Reference Number:†
2011-40-131 to the Internal Revenue Service Commissioner for the Wage
and Investment Division.

IMPACT ON TAXPAYERS

The
Internal Revenue Service (IRS) continues to transition from its existing
electronic filing (e‑file) platform, referred to as the Legacy e-File
system, to the Modernized e-File (MeF) system. †The MeF system provides real-time processing
of tax returns and extensions that will improve error detection, standardize
business rules, and expedite acknowledgments.

WHY TIGTA DID THE AUDIT

This
audit was initiated because, once fully implemented, the MeF system will
replace the current Legacy e-file
system.† The objective of this review was
to evaluate the continued implementation of the MeF system to determine whether
individual income tax returns will be accurately and timely processed and
whether sufficient progress is being made to replace the Legacy e-File system.

WHAT TIGTA FOUND

Processes
used to test and monitor the MeF system do not ensure MeF system business rules
designed to validate basic requirements on a tax return are working as intended.† As a result, the IRS continues to have
limited assurance that the MeF system is accurately processing individual tax
returns.†

In
addition, lower than expected tax return transmitter participation and tax
return volumes raise significant concerns regarding the IRSís ability to fully
replace the Legacy e-File system for
the 2013 Filing Season.† For example, only
19 (28 percent) of the 67 tax return preparation software packages used to file
tax returns in the Legacy e-File system
were used to file MeF tax returns.† Also,
the IRS received only 8.7 million individual tax returns through the MeF system
as of April 18, 2011, significantly lower than the 35 million tax returns the
IRS expected for the 2011 Filing Season.†

Finally, the IRS has not
pursued the use of the MeF system as an option to scan and attach supplemental
information to e-filed tax returns.

WHAT TIGTA RECOMMENDED

TIGTA
recommended that the Commissioner, Wage and Investment Division, develop a
comprehensive testing plan to ensure MeF system processing is accurate and
adheres to the methodology developed.† In
addition, the IRS should correct the 12 errors TIGTA identified in our prior
review of MeF system processing and continue to work with tax return
transmitters and States to identify and address concerns with MeF system
performance.† The IRS should also ensure
MeF system testing includes testing of system performance, stability of web services,
and processing capacity. †Finally, the
IRS should adequately test the MeF systemís ability
to receive, process, store, and retrieve tax return attachments and promote the
use of such attachments.†

IRS management agreed with four of our six recommendations.† Management did not agree to develop a
comprehensive testing plan and indicated that the MeF system was developed
under the Enterprise Life Cycle guidance, which included various testing and
certification processes.†
Notwithstanding, the IRSís three‑phase plan to test the processing
of tax returns through the MeF system in the 2011 Filing Season was
incomplete, and the IRS did not fully execute the steps in the test plan.

Management also disagreed with the recommendation to correct the
12 errors TIGTA identified in its review during the 2010 Filing Season that
resulted in incorrect notifications to taxpayers when tax returns were
rejected.† The IRS indicated it had already
corrected this problem; however, it has not provided any evidence the problem
has been corrected.

†††††††††††††††††††††††††††††††††††††††† Deputy
Inspector General for Audit

SUBJECT:††††††††††††††††††† Final
Audit Report Ė Low Participation and Tax Return Volumes Continue to Hinder the
Transition of Individual Income Tax Returns to the Modernized e-File System
(Audit # 201140030)

This report presents the results of our review to evaluate
the continued implementation of the Modernizede-File (MeF)system to determine whether individual income tax returns will be
accurately and timely processed and whether sufficient progress is being made
to replace the Legacy e-File system for
individual tax returns in the 2013 Filing Season.† This audit is included in our Fiscal
Year 2011 Annual Audit Plan and addresses the major management challenge of
Implementing Health Care and Other Tax Law Changes.

In response to the report, Internal Revenue Service (IRS) management
stated that the report contains mischaracterizations with respect to the
overall quality control process and disagreed with our characterization that
the MeF system underwent ďlimited testingĒ because our report principally focuses
on post‑deployment verification steps.†
We are concerned with IRS managementís response in that they are fully
aware that we have conducted both pre-deployment and post-deployment reviews. †The IRSís pre-deployment efforts are addressed
in a separate report issued earlier this year.[1]† Management also indicated the comparison of
the number of tax returns filed with the MeF system to the number of tax
returns prepared using MeF tested and approved software is not a valid
comparison.† We are concerned with this
statement also because we used this comparison at the request of IRS
management.† IRS management provided us
with the information needed to make this comparison.

Managementís complete response to the draft report is
included in Appendix VI.

Copies of
this report are also being sent to the IRS managers affected by the report
recommendations.† Please contact me at
(202) 622-6510 if you have questions or Michael E. McKenney,
Assistant Inspector General for Audit (Returns Processing and Account Services),
at (202) 622-5916.

The Modernized e-File (MeF)
system is a modernized, Internet-based electronic file (e-file)platform that is replacing
the current Internal Revenue Service (IRS) e-filing
system (referred to as the Legacy e-File
system).† Tax returns and attachments
submitted through the MeF system use extensible markup language (XML), which is
a different format than used in the Legacy e-File
system.[2]† Once fully implemented, the MeF system will
provide a single method for filing all business and individual tax returns,
forms, and schedules via the Internet.† The
MeF system provides real-time processing of tax returns that improves error detection,
standardizes business rules, and expedites acknowledgments.† The MeF system also allows for attachments in
Portable Document Format (PDF).[3]† Figure 1 provides a comparison of key
features between the MeF and Legacy e-File
systems.

Figure 1:† Comparison of the MeF and Legacy e-File
Systems

Condition

MeF e-File System

Legacy
e-File System

Data Format

XML.

American
Standard Code for Information Interchange.

Attachments

Accepted
in the PDF.

No
attachments accepted.

Transmissions

Transaction
based system Ė processed on receipt.

Batch
return system with batches processed three times daily to process
transmissions.

MeF system Release 6.2 includes the ability to file a U.S.
Individual Income Tax Return (Form 1040) for Tax Years (TY)[5] 2009 (prior year) and 2010
(current year)

The first phase of the MeF system (Release 6.1) for
individual income tax returns included the Form 1040, Application for Automatic
Extension of Time To File U.S. Individual Income Tax Return (Form 4868), and 21
forms and schedules related to the Form 1040 for TY 2009.† The IRS first began accepting individual tax
returns through the MeF system in February 2010.

The second phase of the MeF system (Release 6.2) for individual
income tax returns was implemented during the 2011 Filing Season.† Release 6.2 does not provide for the filing
of any additional tax forms or schedules.†
The primary difference between the functionality of Releases 6.1 and 6.2
is the ability for individual taxpayers to file prior year tax returns.† For example, for the 2011 Filing Season,
individual taxpayers were able to file both their TY 2009 and TY 2010 tax
returns using the MeF system.† Appendix IV
details specific tax forms and schedules that were accepted by the MeF system as
part of Release 6.2.

The IRS plans to fully implement the MeF system during the
2012 Filing Season, with the expectation that all individual income tax returns
currently processed through the Legacy e-File
system will be able to be filed through the MeF system.† This includes expanding the MeF system to
process the remaining 129 individual tax forms and schedules currently accepted
by the Legacy e-File system.† The current Legacy e-File system is scheduled to be retired at the end of the 2012 Filing
Season (October 2012).

Individual tax returns processed through the MeF system must pass validation
rules to be accepted for processing

The MeF system uses three levels of validation.† Once a tax return has passed all three levels
of validation, it will enter the IRSís tax return validation stream.† While this is a different approach to
validating tax returns than the one currently employed by the Legacy e-File system, all of the Legacy systemís
error reject codes will be included in the three levels of MeF system validation.† The three levels of validation include:

Level 1 Ė Schema ValidationĖ A MeF system tax return is divided into a series of different data
structures.† Schemas provide the basic
definitions for the data elements within each data structure and the
interrelationships among the data elements (i.e., what is required, field
length, data type, allowable field values, etc.).† The MeF system verifies the accuracy of the
data format in the tax return by validating each tax return against the individual
schemas.† If an error is found during the
schema validation, the tax return is rejected.

Level
2 Ė National Account Profile[6]
ChecksĖ The taxpayer, spouse,
and dependent name controls and Social Security Numbers (SSN) contained on the
tax return must match the information on the National Account Profile before
the IRS will accept the tax return for processing.† The MeF system conducts the same basic
verification as the Legacy e-File
system.† As with schema validations, a tax
return is rejected if it fails one or more of the National Account Profile
validations.

Level 3 Ė Business Rule CheckĖ The IRS established criteria or business rules that each tax
return must pass before it can be processed electronically.† The business rules are designed to validate
basic requirements on a tax return, such as income limits for tax credits and
deductions and the need to attach a specific schedule if certain conditions are
present on the tax return.† A tax return
will be rejected if one or more of the business rules are not met.

This review was performed at the Wage and Investment Division
Office of Electronic Tax Administration Headquarters in Washington, D.C., and
the Modernization and Information Technology Services organization Headquarters
in New Carrollton, Maryland, during the period January to June 2011.† We conducted this performance audit in
accordance with generally accepted government auditing standards.† Those standards require that we plan and
perform the audit to obtain sufficient, appropriate evidence to provide a
reasonable basis for our findings and conclusions based on our audit
objective.† We believe that the evidence
obtained provides a reasonable basis for our findings and conclusions based on
our audit objective.

However, our ability to sufficiently determine if the MeF
system was accurately rejecting and accepting tax returns was limited due to
problems obtaining complete electronic MeF system data timely.† The IRS was unable to extract MeF system data
for us in real-time, and our programmers encountered
problems obtaining direct access due to problems interfacing with the IRSís
Oracle platform.† As a result, our
assessment of whether the MeF system was accurately accepting or rejecting tax
returns was based on our evaluation of the IRSís process to ensure the accuracy
of system processing and conducting alternate testing, including determining whether
a judgmental sample of tax returns was correctly accepted or rejected for
processing.† Detailed information on our
audit objective, scope, and methodology is presented in Appendix I.† Major contributors to the report are listed
in Appendix II.

Processes used to validate and monitor MeF system processing
do not ensure the accuracy of processing of individual tax forms and schedules,
including MeF system business rules designed to validate basic requirements on
a tax return.† As a result, the IRS
continues to have limited assurance that the MeF system is accurately
processing individual tax returns.†
Ineffective or insufficient monitoring of tax return processing
increases the risk that individual tax returns processed through the MeF system
will be erroneously accepted or rejected.†
This risk will grow as the volume of tax returns processed through the MeF
system increases and the types of forms and schedules are expanded.

IRS processes were not
effective in ensuring the accuracy of 56,224 rejected tax returns and more than
1.3 million accepted tax returns.

Although no new forms or schedules were added for the 2011
Filing Season, the IRS still had to modify its computer programs to ensure they
accurately reflect the tax law in effect for the applicable tax year.† For example, for the 2011 Filing Season, the
IRS had to ensure inflation adjustments, adjustments to income limits, new tax
credits, and other legislative changes were correctly programmed and applied to
TY 2010 tax returns in addition to maintaining the TY 2009 amounts.† For the 2011 Filing Season, the IRS had 28 documented
requests for MeF system programming changes to correct system errors in
addition to the changes necessary to implement new tax legislation.† Despite the substantial modifications made
for the 2011 Filing Season, system validation was deficient to ensure the
accuracy of these modifications as they relate to the processing of tax returns
through the MeF system.

The inadequacy of processes to test and monitor the MeF system
is the same condition we reported in our review of MeF system processing in the
2010 Filing Season.[7]†We reported that the IRSís monitoring of
MeF system processing was ineffective.†
To address these concerns, we
recommended that the IRS establish processes to timely monitor the
transmission and processing of tax returns through the MeF system.† The established processes should identify
trends that may indicate problems with the inaccurate rejecting or accepting of
tax returns and ensure rejected tax return explanations sent back to
individuals are correct.

The IRS agreed with
our recommendation, indicating that for the 2011 Filing Season, the IRS would
use a computer application to analyze available tax return data to identify
trends that may indicate errors in tax return processing and to ensure rejected
tax return explanations are correct.† The
IRS noted that these capabilities would enhance its ability to select an
optimal sample size of MeF system tax returns to review, enhance the
effectiveness of the actual review of those tax returns, and improve the
overall monitoring of tax returns as they are processed. †While the IRS took actions to address our
concerns, the actions taken were insufficient and resulted in little improvement
in the monitoring of individual tax returns e-filed
through the MeF system.

Limited testing significantly restricted the IRSís
ability to determine if the MeF system is accurately processing individual tax
returns†

For the 2011 Filing Season, the IRS developed a three-phase
plan to test the processing of individual tax returns once Release 6.2 was
implemented.† Figure 2 provides a
description of the three-phase test plan.

The first
phase of production validation testing occurred
1 to 2 weeks before the official startup of the MeF system.† During Hub Testing, a limited number of tax
returns were transmitted through the MeF production system by a limited
number of transmitters; they were processed and sent to other downstream
systems to validate that they were being processed accurately from beginning
to end.

January 11, 2011,
through

January
13, 2011

Production
Processing Validation

The second
part of production validation testing occurred after the completion of Hub Testing.† Production Processing Validation continued
at production startup and lasted for 2 weeks or until the number of rejected
tax returns was similar to the rate of rejected tax returns in the Legacy e-file system.

January 18, 2011,
through

January
28, 2011

Form 1040 Schedule
A Production Validation

The
third testing process of production validation was limited to Form 1040 Itemized
Deductions (Schedule A).† A limited
number of Schedule A transmissions were received
from a limited number of transmitters to help test the programming
requirements.[8]† This was necessary because of the passage
of late tax legislation that affected certain itemized deductions.†

Our review determined that IRS plans to validate and monitor
MeF system processing for the 2011 Filing Season individual tax returns were
incomplete.† Specifically, the IRSís
plans did not include steps to verify the accuracy of all MeF system business
rules and to ensure individual tax forms and schedules were accurately
processed.

In addition, for the steps included in the plan, the IRS did
not fully execute the steps, which further resulted in incomplete validation.† These deficiencies significantly limit the
IRSís ability to determine if the MeF system is processing individual tax
returns accurately.† Specifically, the
IRS did not:

Complete its review of 25,469 (98.7 percent) of
the 25,794 TY 2010 accepted tax returns and 12,601 (91.9 percent) of the
13,709 TY 2010 rejected tax returns that should have been tested according
to the IRSís validation plan.[9]† In fact,
the IRS only reviewed 1,108 (0.84 percent) of the 132,684 total TY 2010 tax
returns that had rejected as of the end of the IRSís validation period
(January 28, 2011).

Validate the accuracy of
MeF system processing for 176 of the 377 TY 2010 business rules because no
tax returns rejected for these 176 business rules during the IRSís test
period.† The IRS did not expand its
test period or conduct additional testing to ensure these 176 business
rules were functioning properly.†
Our analysis of tax returns rejected by the MeF system as of April
18, 2011, identified 56,224 tax returns that had one or more reject
conditions relating to these 176 business rules.

∑ Adequately validate 3
of the 23 TY 2010 tax forms and schedules eligible for MeF system processing.† These forms are for reporting employee
business expenses, noncash contributions greater than $500, and penalties for
underpayments of estimated taxes.† The
IRS had no plans to review two of these forms, and for the remaining form, the
IRS did not receive an adequate number of tax returns containing this form during
the test period.† Our analysis of tax
returns accepted by the MeF system as of April 18, 2011, showed that more than 1.3 million
tax returns accepted through the MeF system could have included one of these
forms.[10]

In addition, the IRS completed all of
its testing on January 28, 2011, less than 2 weeks after the filing season
began on January 18, 2011.† With the
exception of 1 day of testing for the Form 1040 Schedule A on February 13, 2011, the IRS did not conduct any
additional testing of MeF system processing.†
Our analysis of tax returns transmitted through the MeF system as of April
18, 2011, identified that the IRS had received less than 16
percent (1.37 million) of the 8.7 million tax returns before it had
completed testing of MeF system processing.

The IRS limited its
testing by time period rather than by testing of specific tax forms, schedules,
or business rules.† By limiting testing
to the beginning of the filing season, the IRS was only able to validate those
tax forms, schedules, and business rules that related to those tax returns
filed during this limited time period.† Prior
filing season trends indicate that some tax forms and schedules are more
prevalent during different times of the filing season.† As a result, tax returns filed early in the filing
season would not be representative of all tax returns filed during the filing season.

We discussed with IRS management our concerns with the IRSís
efforts to verify the accuracy of MeF system processing of individual tax
returns.† Management indicated that they
had to reduce the number of individual tax returns verified during testing due
to limited resources.† In addition,
management indicated that they believed a minimum sample of 10 of any one tax
form or schedule was sufficient to provide assurance that the business rules
applicable to that form were functioning properly.† However, the IRS did not ensure that a
minimum of 10 of each tax form or schedule submitted through the MeF system was
tested.† Our review of Release 6.1 found
that the correct application of a given business rule can be affected by the
conditions present on each individual tax return.† As a result, an error in the application of a
business rule may not appear on the first 10 tax returns rejected for that
rule.

The MeF system individual tax return test plan did
not include an adequate review of prior year tax returns

Acceptance of prior year tax returns
was the sole new functionality in place for the 2011 Filing Season.† Prior to implementation of the MeF system, individuals
who needed to file a tax return for a prior tax year had to file their tax
return on paper, lengthening the time it takes the IRS to process the tax
return and issue any associated refund.†
Our analysis of the IRSís testing of the processing of TY 2009
individual tax returns during the 2011 Filing Season identified that the IRS
did not test 12 (54.5 percent) of the 22 TY 2009 tax forms and
schedules.† According to the IRS, 2,519
TY 2009 individual tax returns were transmitted through the MeF system as of
April 18, 2011.† Of the 2,519 tax
returns transmitted, 634 were rejected.

The IRS did not adequately test the accuracy of
processing of prior year tax returns despite that it was the only new
functionality for the 2011 Filing Season.

The IRS indicated that it evaluated
the processing of TY 2009 individual tax returns received early in the 2011
Filing Season.† The IRS received 5
percent of all rejected and accepted TY 2009 individual tax returns during
the testing period for prior year tax returns.†
Due to the limited number of tax returns reviewed during the testing
process, the IRS cannot be assured that significant errors do not exist in the
processing of individual tax returns. †Some
of the errors we reported in our review of MeF system processing of individual
tax returns during the 2010 Filing Season occurred on 1 or more of the 12 TY
2009 tax forms the IRS did not test.† For
example:

∑Our previous review identified two errors
associated with the Child and Dependent Care Expenses (Form 2441) during the
2010 Filing Season.† The MeF system was
incorrectly rejecting tax returns when there were multiple dependents
identified and the qualified expenses were not child specific.† In addition, the MeF system did not include
an exception to the two-income requirement when a date of death existed for
either the primary or secondary taxpayer.

∑Our previous review indentified a missing
business rule in the MeF system to address the reporting requirements for
taxable interest and dividends on the Interest and Ordinary Dividends (Schedule
B).

The IRS did not ensure that errors identified in the
2010 Filing Season were corrected prior to processing individual tax returns in
the 2011 Filing Season

In our testing of individual tax
returns processed through the MeF system during the 2010 Filing Season, 19 (66
percent) of the 29 business rules[11]
we analyzed as of April 21, 2010, appeared to reject in error or reject the tax
returns without providing accurate explanations as to why they were
rejected.† Although the IRS took
immediate action to correct 6 of the 19 errors, it could not immediately
correct 13 of the 19 errors and indicated the errors would be corrected at a later
date.† We found that while the IRS took
actions to prevent tax returns from rejecting for 12 of the 13 errors we
identified in Fiscal Year 2010,[12]
the action taken did not always correct the condition that caused the errors
and undermined the benefits of the MeF system.†
For example:[13]

During MeF system validation, the IRS
determines that the SSN for the child claimed as a dependent on the
individualís tax return is not a valid SSN (the SSN was not issued by the
Social Security Administration).† The MeF
system correctly rejects the tax return and notifies the individual that the
childís SSN is not valid.† The MeF system
also notifies the taxpayer that the amount of the Health Savings Account
Deduction claimed on the tax return exceeds the maximum allowable amount.† However, the notification is incorrect as the
amount claimed for the Health Savings Account Deduction is within the allowable
limit; therefore, the individual should never have received this notification.

In the example above, rather than fixing
the condition that caused the incorrect notification to be sent, the IRS instead
programmed the MeF system to not verify specific business rules if certain
conditions existed on the tax return.† The
IRS programmed the MeF system to bypass the validation of the maximum Health
Savings Account Deduction limit if the childís SSN is not valid.† As a result, the MeF system will not
determine if the amount of the Health Savings Account Deduction exceeds the
maximum allowable amount until after the taxpayer corrects the childís SSN and
resubmits the tax return.† Subsequent to
correcting the childís SSN, if the IRS determines there is an error with the Health
Savings Account Deduction, the tax return will be rejected to the taxpayer
again.

One of the benefits of the MeF system
is the ability to identify multiple errors on a tax return before the tax
return is rejected.† The IRSís intent is
to have the MeF system identify multiple errors on a tax return before
rejecting the tax return so the taxpayer can address all of the errors at the
same time.† Programming the MeF system to
bypass some checks when certain conditions exist undermines the intent of the
streamlined validation process and reduces the benefits that the MeF system
provides to taxpayers.

In response to concerns we raised regarding inadequate
testing, IRS management indicated that post-implementation testing should be
considered in conjunction with the IRSís pre-implementation testing to
determine if testing was sufficient.† We
agree that the combination of pre- and post-implementation testing should
provide the IRS assurance that MeF system Release 6.2 is functioning
properly.† However, our analysis of the
IRSís pre-implementation testing indicates that processes are not in place to ensure
identified errors are corrected before the initiation of processing.† Our analysis of the MeF Release 6.2
pre-implementation test results indicated that the IRS again identified errors
during testing and not all of the errors were corrected before Release 6.2 was
deployed on January 18, 2011.† As a
result, we cannot rely on the IRSís use of pre-implementation testing for
determining if specific business rules, tax forms, and schedules are being
processed correctly through the MeF system.†
We identified this same issue during the 2010 Filing Season.

Recommendations

The Commissioner, Wage and Investment Division, should:

Recommendation
1:† Develop a comprehensive testing plan to
ensure that a representative sample of all tax forms, schedules, and business
rules applicable to individual tax returns transmitted through the MeF system (rejected
and accepted) throughout the filing season is reviewed and all business rules
applicable to those tax returns are verified.†
In addition, the Commissioner should ensure that the IRS adheres to the methodology
developed for testing the accuracy of MeF system processing.

Managementís
Response:†
IRS management disagreed with this recommendation.† The MeF system was developed under the
guidance on the Enterprise Life Cycle Ė Enterprise Life Cycle Guidance, IRM
2.16.1.† The Enterprise Life Cycle is the
approach used by the IRS to manage initiatives and implement changes in
business information systems.† It
provides a comprehensive project management structure for systems development
that includes extensive planning, risk analysis, development, testing,
milestone reviews, and certification processes.†
Testing activities include System Acceptability Tests, System
Integration Tests, Government Acceptance Tests, and Final Integration
Tests.† Prior to its deployment into the
production environment, MeF Release 6.2, used in the 2011 Filing Season,
was cleared by the Submission Processing Executive Steering Committee as having
met and passed all milestone objectives and requirements.

Office
of Audit Comment:† We have and will continue to conduct both a
pre‑deployment and post-deployment review of the MeF system.† As IRS management indicates in their response,
after-the-fact verification once a system is in use is a necessary
element.† Our review focused on the IRSís
efforts to ensure individual tax returns are accurately and timely
processed.† In response to our previous
review, the IRS indicated that it would implement a three-phase plan to test
the processing of tax returns through the MeF system in the 2011 Filing
Season.† However, as we reported, the
IRSís plan was incomplete, and the IRS did not fully execute the steps included
in the test plan.†

Recommendation
2:† Correct the 12 errors we identified in our
review of MeF system processing during the 2010 Filing Season that resulted in
incorrect notifications to the taxpayers when the tax returns were rejected.† Actions taken should address the cause of the
error, not simply prevent the notifications from occurring.

Managementís
Response:†
IRS management disagreed with this recommendation.† The 12 errors were not related to any coding
defect in the National Account Profile or the business rules.† The problem was with incorrect entity data
provided by the taxpayer on the tax return.†
Since the 12 business rules reference the same entity data, if the
business rule results in a reject, any of the remaining business rules may
reject as well.† The corrective action the
IRS took was to program the MeF system to bypass the remaining business rules
(preventing the erroneous notifications) and subsequently reject the
return.† Once the taxpayer or preparer
corrects the entity information and the return is resubmitted, the business
rules and the National Account Profile can then accurately validate the data.

Office
of Audit Comment:† In response to our initial inquiry regarding
these errors, IRS management agreed that the MeF system inappropriately and
unnecessarily applied additional business rules when certain business rules
were applied.† They indicated that programming
changes required to fix the problem were ďcomplex and too riskyĒ to implement
during the 2010 Filing Season and would be implemented as part of a future MeF
system release.† They further indicated that
interim actions (the suppression of the erroneous rejects) would be taken to
mitigate the burden on taxpayers.† To
date, the IRS has not provided us with any information supporting that the
actions taken to reduce taxpayer burden corrected the programming errors we
identified.

Lower than expected tax return transmitter participation and
tax return volumes raise significant concern regarding the IRSís ability to
ensure the MeF system can accurately process large volumes of e-filed tax returns and the IRSís
ability to fully replace the Legacy e-File
system for the 2013 Filing Season.† Any
disruption in the processing of e-filed
individual tax returns after the IRS retires its Legacy e-file system could be catastrophic to the success of the IRSís e-File Program and its ability to
successfully complete the processing of individual tax returns during the 2013 Filing
Season.

The IRS continues to receive
significantly fewer individual tax returns through the MeF
system than is needed to adequately test system capacity.

Despite the IRSís continued efforts to encourage tax return
transmitters and States to use the MeF system for e-filing individual tax returns,
the volume of individual tax returns transmitted through the MeF system continues
to be significantly lower than the IRS expected.† As a result, the IRS is still unable to
adequately test the systemís capability to simultaneously process large volumes
of individual tax returns.† For example,
on the highest volume day, the Legacy e-File system processed 3,352,201 e-filed tax returns compared to
the MeF systemís highest volume day with 329,463 e-filed tax returns
processed.† Figure 3 provides a
comparison of the number of tax returns transmitted daily through the MeF
system and the Legacy e-file system from January 21, 2011,
through April 18, 2011.

Figure 3:†
Comparison of Tax Returns Transmitted Daily Through
the MeF
and Legacy e-File Systems From January 21, 2011, Through April 18, 2011

Figure 3 was removed due to its size.†
To see Figure 3, please go to the Adobe PDF version of the report on the
TIGTA Public Web Page.

The two primary
goals to be achieved during the first two phases of MeF system implementation
(2010 and 2011 Filing Season) were to allow the IRS to test the MeF systemís
basic functionality and ability to receive and process a large number of
individual tax returns simultaneously.†
In addition, the phased-in approach would provide tax return
transmitters and States the opportunity to fully develop and test the
functionality needed to transmit individual tax returns through the MeF system.† The IRS has not achieved either of these goals.

Despite the IRSís
efforts to increase participation, we continue to remain concerned that low tax
return transmitter participation and tax return volumes will make it unlikely
that the IRS will be able to transition the e-filing
of all individual income tax returns through the MeF system in the 2013 Filing
Season.† Once the IRS retires the Legacy e-File system in October 2012, any
issues that arise with the ability of the MeF system to receive and process tax
returns could have a significant impact on taxpayers.† As of April 18, 2011, the IRS reported that more
than 100 million individuals e-filed
their tax return.† This number will
continue to grow as the IRS fully implements the mandate for tax return preparers
who prepare more than 10 tax returns a year to file those tax returns
electronically beginning in January 2012.†
An interruption in electronic tax return processing could force
taxpayers to file their tax returns on paper, significantly increasing the
amount of time taxpayers must wait to receive their refunds.

Of further concern
is that the IRSís Modernization and Information Technology Service organization
(the developer of the MeF system) is confident regarding the performance of the
MeF system.† This organization informed
us that based on its testing of the MeF system, it
believes the MeF system can function at expected processing levels.† However, discussions with
representatives from the IRSís Electronic Tax Administration function (the
business user of MeF system) indicate that they also have concerns that system
functionality and processing have not been adequately assessed.† While
the Modernization and Information and Technology System organization has tested
MeF system performance and capacity through Release 6.2, it has not been able
to test the system for a sustained time period.†
Without such testing, the IRS cannot be assured the MeF system can
efficiently and accurately process the approximately 100 million e-file tax returns individuals file each
year.

Participation in the MeF system by tax return transmitters
and States continues to be low

Tax return
transmitters and States continue to be reluctant to use the MeF system.† In response to our survey, both tax return
transmitters and States continue to raise concerns as to whether the transition
to the MeF system will go as planned.†
The IRS must be responsive to tax return transmittersí and Statesí
concerns so that they will participate in the MeF system now rather than
later.† After the 2012 Filing Season, the
only means of e-filing will be
through the MeF system.† IRS management
indicated that they were confident tax return transmitters would make the
switch to the MeF system rather than lose the ability to e-file tax returns.† The loss
of tax return preparersí ability to e-file
tax returns is not an option as there is a legislative mandate[14] requiring preparers to e-file.† Beginning in January
2012, tax return preparers who prepare more than 10 tax returns a year
must e-file those tax returns.

The number of tax return transmitters and States
participating in the MeF system has more than doubled since the 2010 Filing
Season, increasing from 22 tax return transmitters and States during the 2010
Filing Season to 45 tax return transmitters and States during the 2011 Filing Season.† Figure 4 provides a comparison of the number
of tax return transmitters and States participating in the MeF system for the
2010 and 2011 Filing Seasons.

Figure 4:†
Comparison of Tax Return Transmitters
Using the MeF System as of April 18, 2011

However, tax return transmittersí level of participation in
the MeF system remains low.† According to
the IRS, tax return transmitters used 67 tax return preparation software
packages to prepare and submit tax returns through the Legacy system during the
2011 Filing Season.† Of the 67 software
packages used to prepare and submit tax returns in the Legacy system, only 19 (28 percent)
were used to e-file MeF tax returns.[16]† In addition, the IRS indicated that 81.4 million
tax returns were prepared using software approved for use with the MeF system
but were submitted to the Legacy system. This equates to 82.2 percent of
the 99 million tax returns submitted to the Legacy system as of July 14,
2011.† Despite the large number of tax
returns associated with MeF-approved software, the number of tax returns filed
through the MeF system (9.6 million as of July 14, 2011) remains
considerably less than what the IRS anticipated.†

Tax return transmittersí and Statesí participation in the MeF
system is voluntary.† Tax return
transmitters and States that intended to participate had to successfully
complete the IRS testing process to ensure their systems met MeF system processing
requirements for individual tax returns before they could begin transmitting
tax returns through the MeF system.

IRS management indicated that issues encountered and
decisions made by the three largest tax return transmitters resulted in the
volume of tax returns processed through the MeF system being lower than
expected for the 2011 Filing Season.†
These 3 transmitters process approximately 61.3 million e-file tax returns.[17]† The IRS anticipated that these transmitters
would e-file 40.4 million tax returns
using the MeF system for the 2011 Filing Season.[18]† Only 6 million (14.9 percent) of the
anticipated 40.4 million were e-filed
through the MeF system.† Issues encountered
and decisions made by these transmitters included:

∑Two of the three tax return transmitters had
problems with the development of the software they market to tax return
preparers, which drastically reduced the number of tax returns processed through
the MeF system during the beginning of the filing season.†

∑The third tax return transmitter decided at the
last minute not to participate in MeF system processing until March 1,
2011.† Even then, this transmitter
decided to only transmit returns from a small portion of its tax preparer
community around the country.†

Significant
concerns regarding technical expertise and system performance hinder transmitter
and State participation in the MeF system

We attempted to
solicit input regarding MeF system participation from 19 approved tax return
transmitters and 27 States to obtain their feedback on the MeF system.† We received responses from 11 tax return
transmitters (10 participating and 1 not participating) and 15 States (6 participating
and 9 not participating).† Survey results
identified that State participation is dependent on internal factors, while tax
return transmitter participation is based on concerns with MeF system
performance.† Of the States not
participating in the MeF system that responded to our survey:

∑Four
States indicated that their participation in the MeF system has been hindered
by limitations on the number of available personnel with the technical training
and expertise necessary to develop an electronic filing system that would be compatible
with the IRSís requirements for the MeF system.†
In a depressed economy, the need to allocate limited funding among
projects with the highest priorities results in less funding available to
acquire needed computer programming talents and computer equipment.

∑One
State reported problems with its computer or network that facilitates the
sending and receiving of MeF system transmissions over the Internet.† Technological problems with computer hardware
limit the ability to connect between networks for transmitting data.

∑Two
States indicated that they were unable to participate in the MeF system because
approved tax preparation software developers had not yet developed a MeF system
version of their individual tax returns.†
The IRS indicated that most tax return transmitters will use the
Legacy e-File system to transmit
Federal tax returns if the State tax return must be transmitted using the Legacy
e-File system, even if the return
could otherwise have been transmitted in the MeF system.

While State participation in the MeF system appears
to be limited by internal factors, our surveys of the approved transmitters
indicated the lack of participation is due in some part to concerns with the
performance and capability of the MeF system.†
For example:

∑Four tax
return transmitters were concerned with the performance of the MeF system,
citing concerns with the timeouts they experienced during the 2011 Filing
Season.† A timeout is an interrupt signal
generated by a program or device that has waited a certain length of time for
some input but has not received it.† For
example, a timeout for the MeF system would prevent tax return transmitters
from transmitting tax returns or receiving a response from the MeF system.† Tax return transmitters reported delays in
retrieving information, delays in receiving acknowledgements, and/or timeouts three
times between January 20, 2011, and April 18, 2011.† The IRS closed the last reported incident by stating
that it has been working to identify the root cause to prevent this from
happening in error again in the future.

Two tax return transmitters were concerned that the IRS
implemented major schema[19] changes for the 2011 Filing
Season.† Transmitters may need to modify
their computer programs that prepare tax return files for transmission
each time the IRS makes changes to the schema, or MeF system database
structure, for individual tax returns.†
The time it takes to complete these changes can affect the number
of tax returns a transmitter is able to send through the MeF system.

Three tax return transmitters voiced
concerns that tax returns were rejected in the MeF system that would not
be rejected in the Legacy e-File
system.† Tax returns may be rejected
in error if a business rule is programmed incorrectly in the MeF system.† The same tax return would be accepted
for processing in the Legacy e-File system.† As discussed previously, the risk of
such errors is high because of the limitations in the IRSís MeF system testing
and monitoring plan.† In addition,
it is possible for a tax return to be rejected in the MeF system if the tax
return is not sent in a specified format or schema.†

Two
tax return transmitters were particularly concerned with the reliability of the
web services the IRS is usingto
receive tax return transmissions and send acknowledgements to tax return
transmitters via the Internet.† One tax
return transmitter claimed that the web services the IRS is using are unstable
and have a limited ability to handle a large number of simultaneous
transactions.† The other transmitter
responded that one of the symptoms of the unstable service is a repeated number
of system timeouts.

We raised the
transmittersí concerns with the MeF system web services to IRS management.† IRS management indicated that numerous
improvements were made for MeF Release 6.2 to enhance system performance.† In addition, management stated the system was
stable and indicated that most of the external customers they have spoken to have
complimented them on MeF system performance.†
Management also indicated they have conducted testing of the web
services used by the MeF system and are confident the services are adequate to
handle the current volume of individual tax returns being processed through the
MeF system.† Additional testing of the
web services is planned as the IRS expands the use of the MeF system for
individual tax returns.† We referred the
concerns we received regarding the reliability of the MeF system web
services to our Security and Information Technology Services program.

The
volume of tax returns e-filed through the MeF system is significantly short of
IRS goals†

The number of
individual tax returns transmitted through the MeF system as of April 18, 2011,
(8.7 million) is significantly lower than the 35 million individual tax returns
the IRS anticipated for the 2011 Filing Season.†
Figure 5 provides a comparison of the volume of individual tax
returns transmitted through the MeF system as of April 18, 2011, compared to the
number of tax returns the IRS expected to receive during the 2011 Filing Season.

Figure 5: †2011 Filing Season Volume of Individual Tax
Returns E-Filed Through the MeF System (Expected Versus Actual, as of April 18, 2011)

Figure 5 was removed due to
its size.† To see Figure 5, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.

The tax return volume is low despite the fact that the IRS began accepting
individual tax returns through the MeF system approximately 30 calendar days
earlier than it did last year.† Although
the volume received is substantially lower than expected, it has increased over
the number of tax returns filed through the MeF system during the 2010 Filing
Season.† For example, as of April 18,
2011, the volume of individual tax returns filed through the MeF system (almost 8.7 million tax returns) has increased
by 729 percent when compared to the volume filed through the MeF system for all
of the 2010 Filing Season.† However, the
number of tax returns filed through the MeF system represents only 7.3 percent
of the total population of tax returns e-filed as of April 18,
2011.† Figure 6 below compares the volume
of tax returns e-filed through the MeF and Legacy e-File systems.†

Figure 6:† 2011 Filing Season Tax Return Receipts as of
April 18, 2011

Figure 6 was removed due to
its size.† To see Figure 6, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.

Our prior review
reported the same concerns with MeF system participation and tax return volumes
as we are reporting for the 2011 Filing Season

In our prior review,[20] we reported that lower than expected tax return transmitter
participation and tax return volumes limit the IRSís ability to evaluate the
performance of the MeF system.† The IRS
anticipated processing 9.3 million tax returns through its MeF system by April
15, 2010.† However, the IRS only received
752,320 tax returns (8 percent).† As a
result, the IRS was unable to assess the capability of the system to handle
large volumes of tax returns.† We
recommended that the IRS work with tax return transmitters and States to
identify and address concerns and conditions that prevented them from
participating in the MeF system and encourage them to participate in it during
the 2011 Filing Season.

Management agreed with our recommendation, stating
that they had begun working with tax return transmitters and States to identify
and address concerns and conditions that prevented them from participating in
the MeF system and encourage them to participate in the MeF system during the
2011 Filing Season.† The IRS also stated
that efforts were underway to identify and implement system performance
enhancements to ensure the MeF system can process the anticipated volume of
individual tax returns for the 2011 Filing Season.† The IRS noted that it has taken steps to
address tax return transmitter and State concerns with the performance of the
MeF system.† The IRS indicated implementation of this recommendation would start August
15, 2010, and continue through the 2012 Filing Season,
with a target completion of April 15, 2012.†
We are conducting a separate review to assess the IRSís
specific system performance enhancements.

Recommendations

The Commissioner, Wage and
Investment Division, should:

Recommendation 3:† Continue to work with tax return
transmitters and States to identify and address concerns and conditions related
to MeF system performance and the use of web services for the efficient transmission
of individual tax returns that are hindering their participation in MeF system individual
tax return filing.

Managementís Response:† IRS management agreed with the
recommendation.† The IRS will continue to
work with the tax return transmitter and States to leverage various forms of
communication to identify and address concerns, as well as to promote features
and benefits of the MeF program.† These
outreach/communication activities include:

The IRS
will continue to use its well established issue tracking and defect process,
the Integrated Technology Asset Management System, to address MeF Assurance
Testing System testing and production issues.

Recommendation 4:† Ensure MeF system
testing includes an assessment of the reliability of the MeF system performance
and the use of web services for individual tax return transmissions.† Testing should also provide assurance that
the MeF system has the capacity necessary to receive, validate, and process the
entire volume of individual e-file tax returns the
IRS expects to receive during the 2012 Filing Season, not just those it
anticipates receiving through the MeF system.†
Such an assessment is vital if the IRS intends to retire the Legacy e-file system at the end of the 2012 Filing
Season.

Managementís Response:† IRS management agreed with the
recommendation.† During the Performance
Testing activities, the IRS will test a variety of return-type mixes and
volumes to simulate the production volume expected during the 2012 Filing
Season and the total e-file volume.

One of the benefits of the MeF system is the ability for
taxpayers to attach supplemental information to their tax return in a PDF file.† The IRS indicated that the Legacy e-File system was unable to handle the
wide variety of required and recommended supporting documents that would have
to be scanned and submitted.

The IRS indicated that it has tested the ability of the MeF
system to receive and process PDF attachments.†
This testing included individual tax returns with attachments of varying
sizes.† Tax return transmitters have
reported transmitting some tax returns with PDF attachments through the MeF
system.† However, as with tax returns
without PDF attachments, we remain concerned that the volume of tax returns
with PDF attachments received may not be enough to provide the IRS with
sufficient information to evaluate whether or not the MeF system can
effectively receive, process, and store a large number of tax returns with PDF
attachments.

IRS and tax return transmitters
are not promoting the ability to attach scanned documents to tax returns e-filed
through the MeF system

The IRS has not pursued use of the MeF system as an option
when individuals are required to provide specific documentation with their tax
returns.† For example, recent documentation
verification requirements for claiming the First-Time Homebuyer Credit and
Adoption Credit meant that individuals claiming these credits had to file paper
tax returns and could not e-file
their tax returns.† The MeF system
provides the IRS with the ability to allow these individuals to scan and attach
documents to their e-filed tax returns.
†In addition, the IRS is not actively
marketing the ability to attach supplemental information to individual tax
returns e-filed through the MeF
system.

Tax return transmitters are not
offering taxpayers and tax return preparers the option to attach PDF documents
to a tax return.

We reviewed various sources of information related to MeF system
functionality and found that the IRS has made transmitters aware of the ability
to send attachments with a tax return.†
However, transmitters are raising concerns regarding MeF system
performance and the attaching of scanned documents to individual tax
returns.† During a May 2011 meeting that
the IRS had with tax return transmitters, concerns were raised about the impact
that different sizes of scanned documents and the increase in size of the tax
return file with PDF attachments would have on MeF system processing.† The IRS also asked tax return transmittersí
opinions on the reasonableness of requiring a limited number of tax forms and
schedules (10) that currently cannot be e-filed
in the MeF system to be included as PDF documents during the 2012 Filing
Season.† These tax forms and schedules
are low volume.† Including these as a PDF
would alleviate the need to develop programming for these tax forms and
schedules to be accepted via the MeF system for the 2012 Filing Season.† Requiring certain supplemental information to
be filed as a PDF document would provide the IRS with valuable information
regarding the ability of the MeF system to receive, process, and store tax
returns with PDF attachments.† Two of the
tax return transmitters in the meeting stated they would choose to file tax
returns in the Legacy e-File system rather
than use the PDF function in the MeF system.

Our surveys of tax return transmitters confirmed the concerns
raised by the two tax return transmitters in the May 2011 meeting.† We identified that tax return transmitters do
not appear to be receptive to including PDF attachments when filing individual
tax returns.† While tax return
transmitters are aware that PDF documents can be filed with an individual tax
return, six tax return transmitters who responded to our survey indicated they
have not provided individuals with the use of this option or only provided it
on a limited basis.

Although the IRS has fully developed and implemented the
capability for the MeF system to accept scanned files, anticipating the number
of scanned documents that the IRS may require and receive in the future
presents an added challenge to the IRS in planning the capacity needed to
effectively receive, process, and store tax returns in the MeF system.† If the IRS does not adequately plan for the
ability to receive, store, and retrieve PDF tax return attachments, it could
undermine a very valuable benefit of the MeF system and jeopardize the IRSís
ability to effectively implement future tax law changes with the least impact
on taxpayers.†

Recommendations

The Commissioner, Wage and
Investment Division, should:

Recommendation
5:†Adequately test the MeF system to ensure MeF
system functionality related to receiving, processing, storing, and retrieving
PDF attachments for individual tax returns.†
Testing should include an assessment of the impact various sizes and
types of PDF documentation has on MeF system functionality.

Managementís Response:† IRS management agreed with this
recommendation and believes it is addressed through testing of MeF system functionality
prior to production implementation.† For
the 2011 Filing Season, PDF functionality was tested for all types of PDF
attachments supported by the MeF system for individual tax returns.† Testing was performed using PDF files of
varying sizes, including files greater than 60 megabytes, which caused the
returns to be rejected.† Testing was
performed to verify that the MeF system could receive and process the full
variety of PDF files, and testing was performed on the Modernized Tax Return
Database system to verify the system could store and display tax returns,
forms, and schedules with PDF attachments.†
The same level of testing will be performed as part of the IRSís annual
testing for the 2012 Filing Season and is scheduled for completion by December
30, 2011.

Recommendation 6:† Promote the functionality
of the MeF system in accepting scanned attachments.† In particular, the IRS should offer the use
of e-filing through the MeF system when
specific documents are required to be attached to an individual tax return in
support of credits, deductions, etc., for which the IRS has required taxpayers
to file a paper tax return.

Managementís Response:† IRS management agreed with this
recommendation.† The IRS will continue to
promote the benefits of PDF attachments via the IRS.gov website, in industry
calls and meetings, and in IRS publications and other literature.

While it
is preferred that all forms and schedules implemented on the MeF platform be
submitted in XML format in support of the IRS data strategy, there are certain
situations in which PDF attachments are accepted, such as late legislation,
other unscheduled forms changes, and unstructured data (signatures or third-party
documentation).

As with
other deployment decisions, the IRS will continue to seek internal and external
input and will determine on a case-by-case basis the best format (XML, PDF, or
paper) for processing forms and supporting documentation.

The overall objective of this review was to evaluate the
continued implementation of the MeF system to determine whether individual
income tax returns will be accurately and timely processed and whether
sufficient progress is being made to replace the Legacy e-File system for individual tax returns in the 2013 Filing Season.[21]† To accomplish this objective, we:

I.Determined whether the IRS correctly addressed issues
identified in our Fiscal Year 2010 review of the implementation of MeF system Release
6.1[22]
and verified changes were made for Processing Year[23]
2011.†

A.Obtained
documentation of requested MeF system programming changes from the IRS Work
Request Management System to determine whether programming changes were made to
correct issues identified in our review of the MeF system Release 6.1.

B.Analyzed
the programming changes described in the IRS Work Request Management System to
determine if the changes made resolved the issues identified in our review of
the MeF system Release 6.1.

II.Determined whether the MeF system correctly rejected
and accepted individual income tax returns during the 2011 Filing Season.

A.Obtained
the MeF system documentation needed to allow us, with the assistance of our Information
Services staff and the IRS, to obtain and analyze individual income tax returns
processed by the MeF system during the 2011 Filing Season.

B.Obtained
IRS statistics on volumes of electronic tax returns transmitted in both the
Legacy e-File and MeF systems and
compared the daily volumes.

C.Obtained
the MeF system individual income tax return data that were accepted and
processed from the weekly IRS Individual Return Transaction File[24]
for all accepted and processed tax returns. †We utilized these data to determine whether the
accepted tax forms and schedules were correctly processed and IRS corrective
action to the issues we identified in our prior audit were
effective. †We validated the reliability
of the IRSís Individual Return Transaction File computer-processed data by
comparing it with the IRSís Integrated Data Retrieval System[25]
and Employee User Portal.[26]

D.Surveyed
27 State taxing authorities and 19 approved MeF system transmitters regarding
individual tax returns transmitted through the MeF system during the 2011
Filing Season and additional concerns with the MeF system processing season.

III.Determined
whether the IRS adequately tested and monitored MeF system processing for
individual tax returns during the 2011 Filing Season.

A.Obtained
IRS testing plan and test results from three separate IRS tests, referred to as
ďProduction Validation,Ē conducted in January and February 2011.†

B.Obtained
statistics on volumes of tax returns accepted and rejected in the MeF system
and analyzed the volumes of tax returns reviewed during the IRS testing period.

IV.Determined whether the IRS promoted the capability of
scanning and attaching supplemental information to tax returns in a PDF file.

Internal controls methodology

Internal controls relate to managementís
plans, methods, and procedures used to meet their mission, goals, and objectives.† Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program
operations.† They include the systems for
measuring, reporting, and monitoring program performance.† We determined the following internal controls
were relevant to our audit objective:† the
controls in place to ensure 1) all of the error reject codes included in the
Legacy e-File system were included in
the MeF system and 2) tax returns were properly
accepted or rejected by the MeF system.

During our review of
the processing of individual tax returns for MeF system Release 6.1,[27] we determined that 19 (66 percent) of
the 29[28]
business rules we analyzed as of April 21, 2010, appeared to reject in error or
reject the tax returns without providing accurate explanations as to why they
were rejected.† The IRS took immediate
action to correct 6 of the 19 business rules with errors.† However, the IRS indicated it would correct
the remaining 13 business rules in MeF system Release 6.2.† Figure 1 describes the 6 broad issues that
resulted from errors in the 13 business rules for which corrective action
was not taken during the 2010 Filing Season[29]
and the status of the IRSís actions to correct the errors as of April 18, 2011.† Each issue described may have been caused by
one or more of the 13 business rules we identified in our review of MeF Release
6.1.

Figure 1:† Description
of MeF System Release 6.1
Errors Not Corrected During the 2010 Filing Season

Issue

Date IRS Was
Notified

IRS
Action Taken

Audit
Comment

Programming errors are causing
incorrect rejections when there is a dependent SSN/name control mismatch and
the business rule that requires the dependent SSN and name control to match
the e-file database generates.† If the Earned Income Tax Credit was
claimed, the business rule addressing an SSN/name control mismatch for a
qualifying child also generates.

3/2/2010

Action Planned

The IRS planned to make
changes for Release 6.2 for Processing
Year[30]
2011.† These changes are complex and,
as such, were deferred to a later release to mitigate the risk to the 2010 Filing
Season.† An interim plan was implemented
to mitigate the impact on taxpayers.

The IRS has not
corrected the error.†

Tax returns are
rejecting in error when the taxpayer correctly provided the prior year
Adjusted Gross Income and/or Personal Identification Number as required for
electronically filed returns.

3/2/2010

Action Planned

The IRS planned to make
changes for Release 6.2 for Processing Year 2011.† These changes are complex and, as such, were
deferred to a later release to mitigate the risk to the 2010 Filing Season.† The IRS planned to take interim action to mitigate
the impact on taxpayers.

The IRS has corrected
the error.†

Programming errors are
causing incorrect rejections when there is a primary SSN/name control
mismatch and the business rule that requires the primary SSN and name control
to match the e-file database generates.

3/3/2010

Action Planned

The IRS planned to make
changes for Release 6.2 for Processing Year 2011.† These changes are complex and, as such, were
deferred to a later release to mitigate the risk to the 2010 Filing Season.† The IRS planned to take interim action to
mitigate the impact on taxpayers.

The IRS has not corrected
the error.†

Programming errors are
causing incorrect rejections when there is a secondary SSN/name control
mismatch and the business rule that requires the secondary SSN and name
control to match the e-file
database generates.

3/5/2010

Action Planned

The IRS planned to make
changes for Release 6.2 for Processing Year 2011.† These changes are complex and, as such, were
deferred to a later release to mitigate the risk to the 2010 Filing Season.† The IRS planned to take interim action to
mitigate the impact on taxpayers.

The IRS has not
corrected the error.†

Programming errors are
causing incorrect rejections when there is an employer name/Employer
Identification Number mismatch on Wage and Tax Statement (Form W‑2)
and the business rule that requires the Employer Identification Number to
match the information in the e-file
database generates.† We also noted a
similar condition could exist with payer name/Employer Identification Number
mismatches on Distributions From Pensions, Annuities, Retirement or Profit‑Sharing
Plans, IRAs, Insurance Contracts, etc. (Form 1099-R) and the business
rule that requires the Employer Identification Number to match the e‑file database.

3/5/2010

Action Planned

The IRS planned to make
changes for Release 6.2 for Processing Year 2011.† These changes are complex and, as such,
were deferred to a later release to mitigate the risk to the 2010 Filing
Season.† The IRS planned to take
interim action to mitigate the impact on taxpayers.

The IRS has not
corrected the error.†

Programming errors are
causing incorrect rejections for the Making Work Pay Credit when there is a
primary or secondary SSN/name control mismatch and the applicable business
rules are correctly applied.

3/12/2010

Action Planned

The IRS planned to make
changes for Release 6.2 for Processing Year 2011.† These changes are complex and, as such,
were deferred to a later release to mitigate the risk to the 2010 Filing
Season.† The IRS planned to take
interim action to mitigate the impact on taxpayers.

The IRS has not
corrected the error.†

Source: †Our review of MeF system Release 6.1 and IRS
Unified Work Requests.

We have
reviewed your draft report of the subject audit concerning the Modernized e-File
(MeF) Program. In brief, you have made a number of
valuable recommendations with which we generally agree and will implement,
subject to resource limitations.

We are
concerned however, that this report contains mischaracterizations with respect to
the overall quality control process, and we disagree with the characterization
that the Modernized e-File systems underwent
"limited testing". TIGTA principally reports on the post-deployment
verification steps that the IRS took once the MeF
system was processing live tax returns without any mention or analysis of the
significant testing effort undertaken as part of the software development
process. In our view, this omission is of particular issue when considered in
light of the generally agreed best practice that quality control is most important
during the design and development process. After-the-fact verification once a
system is in use is a necessary element of an overall process, but is
substantially less critical than the upfront testing and quality control.

It is for
this reason that during the 2011 filing season, the IRS adapted its approach to
verification during the filing season and decided to perform fewer
verifications once the system was up and running smoothly. This was a
common sense resource allocation decision.

Regarding the
section in your report "Participation in the MeF
system by tax return transmitters and States continues to be low", we agree
that transmitter participation is lower than where we would like it to be.
However, we believe that the comparison of the number of tax returns filed with
MeF to the number of tax returns prepared using MeF tested and approved software is not a valid comparison.

The report
states that "81.4 million tax returns were prepared using software that
was approved for use with the MeF system but
submitted to the Legacy system." The report also states that 9.6 million
tax returns were filed through MeF. It is not correct
to try and relate the number of tax returns filed with MeF
to the number of tax returns prepared using software that was approved for use
with MeF. A substantial number of the 81.4 million
tax returns include several tax forms and schedules currently not supported by MeF. Once the software packages used to prepare these tax
returns are tested and approved as MeF compliant for
the 2012 processing year, substantially all of these tax returns will be
eligible for MeF processing.

As the report
further states, three transmitters had anticipated submitting 40.4 million tax
returns. Two transmitters encountered issues with their software and the third transmitter
made a business decision to defer MeF processing
until after the extender legislation was deployed into production, resulting in
only 6 million tax returns being submitted to MeF by
these three transmitters. Therefore, this low volume was not caused by any
problems with the MeF application. While W&I did
work with these transmitters on resolving their issues, in the interim, the
transmitters chose to send most of their tax returns to Legacy e-File. Had
these three transmitters submitted through MeF as
originally planned, it is likely that MeF would have
received an additional 34.4 million tax returns. During the MeF
migration transition period (FS 2010 through FS 2012), transmitters determine
which system to send their returns based on their business model.

We agree with
four out of the six recommendations and look forward to continued involvement
by TIGTA in the next phase of the 1040 MeF
deployment.

Our specific
comments to your recommendations are attached. If you have any questions,
please contact me, or a member of your staff may contact Cecille
M. Jones, Acting Director, Electronic Tax Administration and Refundable
Credits, Wage and Investment Division at (202) 622-7990.

Attachment

Attachment

The
Commissioner, Wage and Investment Division, should:

Recommendation
1

Develop a
comprehensive testing plan to ensure that a representative sample of all tax forms,
schedules, and business rules applicable to individual tax returns transmitted through
the MeF system (rejected and accepted) throughout the
filing season is reviewed and all business rules applicable to those tax
returns are verified. In addition, the Commissioner should ensure that the IRS
adheres to the methodology developed for testing the accuracy of MeF system processing.

Corrective
Action

We disagree
with this recommendation. The Modernized e-File (MeF)
system was developed under the guidance of the Enterprise Life Cycle (ELC) -
Enterprise Life Cycle Guidance, IRM 2.16.1. The ELC is the approach used by the
IRS to manage initiatives and implement changes in business information
systems. It provides a comprehensive project management structure for systems
development that includes extensive planning, risk analysis, development,
testing, milestone reviews, and certification processes. Testing activities
include System Acceptability Tests, System Integration Tests, Government
Acceptance Tests, and Final Integration Tests. Prior to deployment into the
production environment, MeF Release 6.2, used in the
2011 Filing Season, was cleared by the Submission Processing Executive Steering
Committee as having met and passed all milestone objectives and requirements.

Implementation
Date

N/A

Responsible
Official

N/A

Corrective
Action Monitoring Plan

N/A

Recommendation
2

Correct the
12 errors we identified in our review of MeF system
processing during the 2010 Filing Season that resulted in incorrect
notifications to the taxpayers when the tax returns were rejected. Actions
taken should address the cause of the error, not simply prevent the
notifications from occurring.

Corrective
Action

We disagree
with this recommendation. The 12 errors were not related to any coding defect
in the National Account Profile (NAP) or the business rules. The problem was with
incorrect entity data provided by the taxpayer on the tax return. Since the 12 business
rules reference the same entity data, if the first business rule results in a reject,
any of the remaining business rules may reject as well. The corrective action
we took was to program MeF to bypass the remaining
business rules (preventing the erroneous notifications) and subsequently reject
the return. Once the taxpayer or preparer corrects the entity information and
the return is resubmitted, the business rules and the NAP can then accurately
validate the data.

Implementation
Date

N/A

Responsible
Official

N/A

Corrective
Action Monitoring Plan

N/A

The Commissioner,
Wage and Investment Division, should:

Recommendation
3

Continue to
work with tax return transmitters and States to identify and address concerns
and conditions related to MeF system performance and
the use of web services for the efficient transmission of individual tax
returns that are hindering their participation in MeF
individual tax return filing.

Corrective
Action

We agree with
this recommendation. We will continue to work with the tax return transmitters
and States to leverage various forms of communication to identify and address
concerns, as well as to promote features and benefits of the MeF program. These outreach/communication activities
include:

We will
continue to use the IRS' well established issue tracking and defect process,
the Integrated Technology Asset Management System, to address MeF Assurance Testing System testing and production issues.

The IRS will
monitor this corrective action as part of its internal management control system.

Recommendation
4

Ensure MeF system testing includes an assessment of the
reliability of the MeF system performance. Testing
should include an assessment of the reliability of MeF
system performance and the use of web services for individual tax return
transmissions.

Testing
should also provide assurance that the MeF system has
the capacity necessary to receive, validate, and process the entire volume of
individual e-file tax returns the IRS expects to receive during the 2012
Filing Season, not just those it anticipates receiving through the MeF system. Such an assessment is vital if the IRS intends
to retire Legacy e-file system at the end of the 2012 Filing Season.

Corrective
Action

We agree with
this recommendation. During the Performance Testing activities, we will test a
variety of return-type mixes and volumes to simulate production volume expected
during the 2012 Filing Season and total e-File volume.

The IRS will
monitor this corrective action as part of its internal management control system.

The
Commissioner, Wage and Investment Division, should:

Recommendation 5

Adequately
test the MeF system to ensure MeF
system functionality related to receiving, processing, storing, and retrieving
PDF attachments for individual tax returns. Testing should include an
assessment of the impact various sizes and types of PDF documentation has on MeF system functionality.

Corrective Action

We agree with
this recommendation and believe it is addressed through our testing of MeF system functionality prior to production
implementation. For the 2011 Filing Season (FS), Portable Document Format (PDF)
functionality was tested for all types of PDF attachments supported by MeF for individual tax returns. Testing was performed using
PDF files of varying sizes, including files greater than 60MB, which cause the return
to be rejected. Testing was performed to verify MeF
could receive and process the full variety of PDF files, and testing was
performed on the Modernized Tax Return Database system to verify the system
could store and display tax returns, forms, and schedules with PDF attachments.
This same level of testing will be performed as part of our annual testing for
the 2012 FS and is scheduled to complete by December 30, 2011.

The IRS will
monitor this corrective action as part of its internal management control system.

Recommendation 6

Promote the
functionality of the MeF system in accepting scanned
attachments. In particular, the IRS should offer the use of e-filing through
the MeF system when specific documents are required
to be attached to an individual tax return in support of credits, deductions,
etc. for which the IRS has required taxpayers to file a paper tax return.

Corrective
Action

We agree with
this recommendation. The IRS will continue to promote the benefits of PDF
attachments via the IRS.gov website, in industry calls and meetings, and in IRS
publications and other literature.

While it is
preferred that all forms and schedules implemented on the MeF
platform be submitted in Extensible Markup Language (XML) format in support of
the IRS data strategy, there are certain situations in which PDF attachments
are accepted, such as late legislation, other unscheduled form changes, and
unstructured data (signature or third party documentation).

As with other
deployment decisions, the IRS will continue to seek internal and external input,
and will determine on a case by case basis the best format (XML, PDF, or paper)
for processing forms and supporting documentation.

[2]The XML
can be used, especially on the worldwide web, to create a tagging scheme that
allows elements of a document to be marked according to their content rather
than their format.

[3] The PDF
is a file format for representing documents in a manner that is independent of
the original application software, hardware, and operating system used to
create those documents.

[4]The period from January through mid-April when most individual
income tax returns are filed.†
However, individuals may continue to file tax returns through October if
they apply for an extension of time to file.

[5]A 12-month accounting period
for keeping records on income and expenses used as the basis for calculating
the annual taxes due.† For most individual taxpayers, the tax year
is synonymous with the calendar year.

[6] The
National Account Profile is a compilation of selected entity data from the IRS
Master Files, which are the databases that store various
taxpayer information.† The
National Account Profile includes all valid and invalid taxpayer entity
information.†

[7]System Errors and Lower Than
Expected Tax Return Volumes Affected the Implementation of the Modernized e-File
System for Individual Income Tax Return Processing (Reference Number
2010-40-111, dated
September 8, 2010).

[8] The IRS
had to delay the processing of tax returns with an accompanying Schedule A to
allow sufficient time to complete computer programming changes necessary for
items on the Schedule A as a result of late legislation.† The IRS began processing the Schedule A on February 14, 2011.

[9] One
objective of the IRSís validation plan included identifying a statistically
valid sample to be used to review and validate production processing end-to-end
to ensure that returns are being processed properly.

[10] These
tax returns contain information that would indicate the taxpayer may be
required to file one or more of the tax forms in question.† However, the IRS does not require the
taxpayer to attach the tax form if certain conditions are met.

[11] We
selected these business rules for review based on the volume and concerns
identified prior to the IRS accepting tax returns through the MeF system on
February 17, 2010.

[12] See
Appendix V for a description of the six broad issues that resulted from the
errors we identified on the 13 business rules in the 2010 Filing Season.

[16] Of the
67 tax preparation software packages used in Legacy, 24 have been approved for
use in the MeF system.†

[17] The
number of estimated tax returns is based on historical filing season data of
the 23 forms supported by the MeF system and represent the maximum
potential volume of tax returns supported by the MeF system.

[18] The
volume estimates include combined Forms 1040, Statesí submissions, and Forms
4868.† The volume estimates were provided
by transmitters.

[19] A
schema change is a change in the data structure of information.† A schema defines the data elements within
each data structure and the interrelationships among the data elements (i.e.,
what is required, field length, data type, allowable field values, etc.).

[20]System Errors and Lower Than Expected Tax
Return Volumes Affected the Implementation of the Modernized e‑File
System for Individual Income Tax Return Processing (Reference Number
2010-40-111, dated September 8, 2010).

[21]The period from January through mid-April when most individual
income tax returns are filed.†
However, individuals may continue to file tax returns through October if
they apply for an extension of time to file.

[22]System Errors and Lower Than
Expected Tax Return Volumes Affected the Implementation of the Modernized e-File
System for Individual Income Tax Return Processing (Reference Number
2010-40-111, dated September 8, 2010).

[23]The calendar year in which the
tax return or document is processed by the IRS.

[24] The
Individual Return Transaction File contains all edited, transcribed, and
error-corrected data from the Form 1040 series and related forms for the
current processing year and 2 prior years.

[25]IRS computer system capable of retrieving or
updating stored information.† It works in
conjunction with a taxpayerís account records.

[26] IRS
computer system used to review tax return information transmitted in the MeF
system.

[27]System Errors and Lower Than
Expected Tax Return Volumes Affected the Implementation of the Modernized e-File
System for Individual Income Tax Return Processing (Reference Number
2010-40-111, dated September 8, 2010).

[28] We
selected these business rules for review based on the volume and concerns
identified prior to the IRS accepting tax returns through the MeF system on
February 17, 2010.

[29]The period from January through mid-April when most individual
income tax returns are filed.†
However, individuals may continue to file tax returns through October if
they apply for an extension of time to file.

[30]The calendar year in which the
tax return or document is processed by the IRS.